Mortgage Buydown: What It Is, Types, and When It Makes Sense

How Rate Buydowns Can Make Buying a Home More Affordable

If you’ve been looking at home prices recently, you're probably aware that buying a home is a major expense—and that’s before you factor in the interest rate. A high interest rate can increase your monthly mortgage payment and stretch your budget. But there’s a strategy you can use to pay more upfront and secure a lower interest rate, potentially making your transition to homeownership easier.

Let’s discuss what mortgage buydowns are, how they work, and how to tell if it’s an option you should explore.

What Is a Mortgage Buydown?

A mortgage interest rate buydown is a strategy to get a lower interest rate when you purchase a home. Buydowns can make monthly payments more affordable by reducing interest payments, so they’re usually more common when mortgage rates are high.

Interest rate buydowns are structured in a variety of ways and can be temporary or permanent. They’re most commonly used for primary residences and are available on several loan types, though rules and limits vary by program and lender.

Buydowns aren’t typically used to refinance loans.

How Do Mortgage Buydowns Work?

In a mortgage buydown, an upfront cost is paid at closing rather than the seller lowering the purchase price of the home. With temporary buydowns, the upfront funds are often placed into an escrow account and applied to your monthly payments. The goal of mortgage buydowns is to make payments more affordable, which can be particularly helpful during the early years of the home loan.

Buydowns are often paid by third parties, including:

• Sellers: Homeowners often pay for buydowns to help close the sale as part of their seller concessions. This allows them to offer lower monthly payments without reducing the listing price.
• Builders: For new construction homes, builders will often use buydowns as a sales incentive.
• Lenders: In lender-paid buydowns, the mortgage lender covers the upfront cost in exchange for a higher base interest rate or other adjusted loan terms. These are typically promotional offers and may come with other trade-offs.

Types of Mortgage Buydowns

There are two main types of mortgage buydowns: temporary and permanent. Both options involve an upfront cost. In temporary buydowns, the loan’s original interest rate remains unchanged, and payments gradually increase until they reach the full amount. Permanent buydowns reduce the interest rate for the life of the loan.

Temporary Buydowns

With a temporary buydown, an upfront fee is paid in return for a lower interest rate during the first years of a mortgage. Temporary mortgage buydowns are typically good for two or three years, with the interest rate changing each year.

• 3-2-1 mortgage buydowns: These buydowns last for three years. During the first year, your interest rate is reduced by 3%. During the second year, it’s reduced by 2%. During the third year, it’s reduced by 1%.
• 2-1 mortgage buydowns: These buydowns last for two years. During the first year, your interest rate is reduced by 2%, and during the second year, it’s reduced by 1%.
• 1-1 mortgage buydowns: These buydowns reduce the borrower’s interest rate by 1% for the first two years of the loan.

Once the buydown expires, your interest rate will return to the loan’s original rate. For example, if your mortgage interest rate is 6%, and you have a 2-1 buydown, then your rate will be 4% during the first year, 5% during the second year, and 6% during the third year.

To qualify for a buydown, you need to be approved for the mortgage at the full interest rate. Using the example above, you’d need to be approved for a loan with a 6% interest rate.

Temporary buydowns are generally not available for investment properties and cash out refinances.

Permanent Buydowns

Permanent buydowns are possible by purchasing mortgage discount points to lower the interest rate for the life of your loan, not just during a buydown period.

Discount points typically cost 1% of the loan amount per point and lower the interest rate by 0.25%. In this scenario, you’d pay mortgage points to your lender in exchange for a lower interest rate, almost like you’re prepaying the interest upfront to have a lower mortgage payment each month.

Mortgage Rate Buydown Example

Buydowns can significantly lower your monthly payments for a short period. Let’s say you took out a $300,000 mortgage with a 6% interest rate and a 2-1 buydown on a 30-year fixed-rate, conventional mortgage. This is what your monthly payments would look like during the first two years and in the third, when the buydown period ended:

To estimate your unique payments, check out our mortgage payment calculator to see what your monthly payments would look like with different rates.

How Much Does It Cost to Buy Down an Interest Rate?

The cost of mortgage buydowns depends on whether the rate reduction is temporary or permanent. Temporary buydowns are more common, and their cost is based on the amount of money you’re saving each month on interest payments during the buydown period. Those funds are typically funded up front at closing.

For example, a temporary 1-1 buydown that saves you $100 a month in interest payments for two years might cost the seller $2,400.

Permanent buydowns, or discount points, are calculated as a percentage of the loan amount and reduce the interest rate for the life of the loan. This means they generally cost thousands of dollars. For example, on a $400,000 loan, one point would cost $4,000, which you’d pay your lender up front.

Pros and Cons of Mortgage Buydowns

Every choice you make regarding your mortgage has potential benefits and drawbacks, including whether to pursue an interest rate buydown.

When a Mortgage Buydown Makes Sense

After weighing the pros and cons, you may decide a buydown is the right choice in certain situations. These can include cases where:

• the seller or builder pays the costs as part of the sales agreement.
• you expect your income to increase.
• you plan to refinance if interest rates drop.
• you’ve got enough cash at closing to cover the upfront costs.
• you want to save money each month without reducing the home’s purchase price or potentially affecting appraisals or its resale value.

If you’re thinking about paying for a buydown yourself, consult a financial professional to decide if the costs make sense for you.

Alternatives to Buying Down Your Interest Rate

On the flipside, if a temporary buydown isn’t the solution for you at this time, you can take an alternate route. Buying mortgage points for a permanent rate reduction is one way, though there are many options.

• Consider an adjustable-rate mortgage (ARM).
• Negotiate a lower purchase price.
• Choose a smaller loan amount.
• Make a larger down payment.
• Refinance down the road if rates drop.
• Go with a shorter loan term (which generally means higher monthly payments, but less cost over the life of the loan).
• Boost your credit score to potentially get a more favorable rate.

Comparing these alternatives with a buydown can help you choose the option that offers the best long-term value.

Final Thoughts: Are Mortgage Buydowns Worth It?

Mortgage buydowns can help you get a lower monthly payment, especially when interest rates are high or when sellers and builders are willing to help cover the upfront cost during a buyer’s market.

Whether a buydown makes sense depends on how long you plan to stay in the home, how it’s structured, and whether the upfront expense means savings that will benefit you over time. When you’re ready to pursue mortgage options, get prequalified with Freedom Mortgage today to see your personalized interest rate.